China’s biggest steel makers are planning to shut unprofitable capacity ­permanently over the second half of 2012 as the impact of slowing Chinese growth continues to shake iron ore markets.

The iron ore price plunged a further 5 per cent to $US90.30 in local trading yesterday, taking the fall over the last fortnight to 20 per cent and placing pressure on the margins of producers such as
Fortescue Metals Group
, as well as Australia’s terms of trade.

With the local currency still locked firmly above parity with the US dollar, spot prices remain near global financial crisis lows of $87 in Australian ­dollar terms at a time when costs have since risen rapidly.

Amid weak demand for steel in China, The Australian Financial Review understands an influential state-owned player will shut a blast furnace near the country’s east coast to set an example to other producers within the next month. “It will be a symbolic move to show other players in the industry that they have to reduce capacity if it isn’t ­making money," an executive in the raw material import department said yesterday.

AFR
AFR

The iron ore price fall comes as the Australian Bureau of Statistics said it expected $119 million to be invested in mining capital expenditure this year, representing the bulk of an estimated $181.5 million of investment across the economy.

Seven Group
chairman
Kerry Stokes
said China’s “giant" economy would be difficult to manage, but ultimately there would be more emphasis on supporting profitable industry.

“An economy of that size is always going to produce areas that go too fast or too slow," Mr Stokes said at the opening of a new WesTrac service ­centre in Newcastle yesterday.

“I think it is slowing down and I think China is going to have a reconfiguration of its economy.

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“I think they’ll move to probably more encouragement of enterprises that are profitable."

Fortescue Metals chief executive Nev Power said he was surprised China hadn’t cut capacity further as the nation struggled with high steel stocks and weak demand.

“I think we are just seeing that natural lag in the market of the length of time it takes to adjust production to suit [the market]," he said.

Mr Power said Chinese officials appeared concerned enough about rising property prices that they hadn’t yet taken much action on reducing interest rates and reserve ratios to stimulate the economy.

However, he said such moves were expected in the fourth quarter, leading to a rebound in iron ore prices to at least $US120 a tonne.

China’s steel mills buy the majority of Australia’s iron ore, but have suffered substantial declines in their margins as the price of steel sits below global financial crisis levels.

Shanghai Futures Exchange prices for reinforcing steel dipped to 3540 yuan a tonne, the lowest level since March 2009, yesterday.

The executive at the Chinese steel maker said banks were now asking mills to prove they were profitable before giving them money to finance raw material shipments.

“It’s definitely getting more difficult, even for big companies like us. We have to show that we’re making money," the executive said.

Mr Power said that to date, his customers had not faced delays in obtaining letters of credit.

“The steel mills are very much hand-to-mouth at the moment because they have been running down their stocks," he told The Australian Financial Review. “But at this stage we are still taking contracts through September and October."

Falling commodity prices have sparked renewed concerns that Australia’s terms of trade could stop growing in the remainder of 2012, putting pressure on budget forecasts and the expected tax take.

Macquarie Group senior economist Brian Redican estimated that lower iron ore and coal prices would cause a $10 billion hit to the federal budget’s bottom line last week. Since then, the spot price has fallen another 10 per cent. “It would be a much larger number today," Mr Redican said, adding that half of the loss would be from lower company tax receipts.

Former prime minister
Kevin Rudd
said yesterday there was “complexity arising from the recognition by the Chinese themselves in the most recent Five Year Plan that the Chinese growth model must change".

The Chinese steel mill executive said he had seen no sign that the country’s leaders were looking to ramp up growth quickly to support steel demand, and stressed that banks were demanding proof that mills could make money before extending lines of credit. “We think there will be another global crisis, and this time it will start in China," he said. “The government knows we are in a difficult situation and there has been no improvement.

“We think this time it will not be easily solved by those policies, it will take more time."

While Fortescue Metals and other Australian miners are still confident that market conditions will improve over the current half, Baosteel executive Zhang Dianbo told Reuters ­yesterday that China’s demand for iron ore would not grow and could fall compared with the first six months of 2012. Mr Zhang said 50 million tonnes of new global supply was expected to pressure iron ore prices.

Macquarie analyst Graeme Train said the price could fall as low as $US80 a tonne if Chinese steel mills kept reducing their stock and steel demand and pricing remained weak.

CLSA analyst Ian Roper said the move to close blast furnace capacity would be a step in the right direction, but that even with 50 million tonnes less steel production over the current half, iron ore prices would have to rebound from current levels to $US120 a tonne by year end.

“I think more people will be coming around to my view that steel capacity will peak at 800 million tonnes," Mr Roper said yesterday.

BHP Billiton and Rio Tinto still say China would peak above 1 billion tonnes by 2020. Rio Tinto was hammered in trading yesterday, with its shares falling to $48.60 – the lowest level since July 2009. Pure play iron ore companies Fortescue Metals Group and Atlas Iron shares were also sharply lower, at two- and three-year lows respectively.

China had set a target to spend the same on infrastructure in 2012 as it had in 2011, but in the first half only achieved 36 per cent of the full-year target, leaving most analysts optimistic that it would markedly accelerate spending over the second half.

However, with steel prices continuing to fall and the export markets for finished goods that consume as much as a third of China’s steel under water, the outlook remains challenging.